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Cement Outlook: 2008 Reed Construction Data Construction Forecast Conference Washington, D.C. October 4, 2007 Ed Sullivan Staff Vice President and PCA Chief Economist Introduction Good News Interest rates, Inflation & Unemployment are Low Net Exports & World Growth Investment Spending Job Growth… if Dismiss Recent News as Outlier 2nd Quarter GDP Growth…if Dismiss Consumer Spending Introduction Fundamentals still sound… ….but is this analysis backwards looking?.. … and not what forward looking? Nearly every downside risk that PCA has warned about in the past is materializing Introduction The economy is weakening. A recession is very possible. Dependent now on job creation and Federal Reserve actions. Dependent consumer & business confidence. PCA new forecast scenario stops short of projecting recession. Further downside risks to forecast projections exist. Introduction “Threat to economy is not a housing issue... it is a financial/credit issue that arose from past mortgage financing.” 2006 Housing 2007 Consumer 2008 2009 Commercial Public Broad Implications: Crisis is No Longer Contained to Housing Key Questions How deep will retrenchment go ? How long will it last ? Economic Outlook Introduction To determine the cause of a slowdown in economic Growth, or even a recession …. …. Look no further than the excesses and imbalances created during the preceding boom period. Debt played important role in 2003-2006 growth. Responsible debt? Easy terms & standards Unprecedented link in consumer spending to housing wealth. Payback is tough – maybe more than consensus of economists believe. Sub-Prime Mortgage Resets Total Loans Scheduled for Reset 50,000 45,000 40,000 35,000 30,000 25,000 Period of Emerging Trouble 20,000 15,000 10,000 5,000 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 Impact on Economic Growth Monthly Payments Increase 50% or More. Credit Card Debt Increases As Consumers Try To Preserve Standard of Living. Delinquencies Increase. Defaults Increase. Adverse Impact on Consumer Spending. Economic Outlook Consumer Spending has Relied On Debt. Consumer Debt Burdens Near Historical Highs Net savings rate has been negative for years. Often a precursor to reduction in consumption growth. Sub-Prime Defaults Force a Tightening in Lending Standards Reflects a new assessment of risk-return philosophy – beyond mortgages and perhaps globally. Tapping Home Equity Not as Viable As In the Past Can Debt Based Consumer Spending Thrive In This Environment? If not, growth in consumer spending slows. Income Growth is Improving – but perhaps not fast enough. Consumer Worksheet Pay Increase Averages 3.5%. Health Insurance Premiums Rise 7%-11%. State and Local Property Taxes Rise. Reassessments based on high home appreciation Energy Prices Take a Large Bite. Perfect Storm?...Resets and Home Heating Season? Inflation Running near 2.4% Slowdown in Job Creation If Job Creation Drops Below 100K on Sustained Basis – Expect a Significant Downward Revision in Forecast. Snap Shot of Economic Activity Government 18% Investment 15% Consumer 69% Consumption acts as the anchor for US economic activity. Any retrenchment in consumer spending will lead to slower economy-wide growth rates Spill Over Effects Slower consumer spending reduces expected ROI on investment (2008) At minimum significant slowdown in nonresidential construction PCA expects a decline. Eventually increases fiscal pressures on government spending (fiscal 2009) Is this the next emerging issue? State fiscal conditions threatened Highway trust fund insolvency Inadequacy of SAFTEA-LU Impact on Economic Growth Adverse Impact on Consumer Spending can be Contained. As Long As…. Relatively Strong Job Growth Persists. And… Interest Rates Remain Stable. Job Growth Projections Thousands of Net New Jobs Created Per Month 400.0 Job Creation is a Key Variable to Monitor Regarding Recession Risks 350.0 300.0 250.0 History Forecast 200.0 150.0 100.0 50.0 Pay Attention to Job Creation 0.0 Revisions…Downward Revisions 2004 2005 2006 occur -50.0 more frequently when economy sliding. 2007 2008 Real GDP Growth Projections Percent Change, Y-O-Y, Real GDP $ 8.0% 7.0% History 6.0% Forecast 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% & Indirect Impacts of Direct 2003.1Crisis2004.1 Sub-Prime Results in 2005.1 Slower Economic Growth 2006.1 2007.1 2008.1 Baseline Scenario AND… …this is PCA’s “Optimistic” scenario! Recession? Base Case: No Recession 35-40% Chance Recession Materializes Next Six Months If recession materializes, it may not be short lived. Significant downside risks exist for 2008 and 2009 construction projections. Nonresidential at risk: 2008-2009 Public at risk: 2009-2010 Construction & Cement Outlook Overview Construction Spending Projections Real PIP Construction $ 8% History Forecast 6% 4% 2% 0% -2% Sub-Prime Crisis May Indirectly -4% Spill Over to Nonresidential & -6% Public Construction -8% 2003 2004 2005 2006 2007 2008 Residential Construction Past Strength in Starts More Than Low Rates… The Cyclical Upside: 2001 - 2005 Low mortgage rates key factor in single family starts over past few years. Emergence of exotic mortgages also a key factor…particularly in strong home appreciation environment. Easy credit conditions contributed to strong home-buying environment. Speculators add froth to market in light of strong appreciation rates. Lean inventories supplement demand …add strength to starts. Each Factor at Work on Cyclical Downside: 2006 – Mid-2009 Boom/Bust Markets Account for Nearly One Third of All Foreclosures Structurally Changed Markets Hurricanes (Louisiana) Economically Depressed (Michigan) Boom/Bust Markets (2010 Recovery) Dynamic Economies Strong Demographics Robust Appreciation Rates High Presence of Speculators Large Inventory Overhang, Large Starts Decline, Slow Recovery Arizona, Nevada, Florida & California = 28% Cement Consumption “Normal” Markets More Modest Appreciation Relatively Low Speculator Presence Smaller Inventory Overhang More shallow decline, Quicker Recovery Home Inventory Thousands of Homes for Sale, April More Than 2 Million Excess Inventories 4500 4000 New 3500 New 3000 2500 New New Existing 2000 Existing 1500 Existing 1000 Existing 500 0 2004 2005 2006 2007 Lenders Reporting Tighter Lending Standards: Mortgages Latest Data: Largest Increase Since Conditions Preceding 1991 Recession Percent Reporting Tighter Lending Standards 20 Tighter Credit Will Undermine Sales 15 Recovery Easy Credit Period 10 5 0 -5 -10 -15 2000Q1 2002Q1 2004Q1 2006Q1 Single Family Price Trend: Existing Homes Compared to Year Ago Levels Percent Change, Year Ago (%) Projected 20.00% 10 High Inventories Will Depress Prices Throughout 2007 and into 2008. 9 15.00% 8 7 10.00% 6 5.00% 5 4 0.00% 3 2 -5.00% 1 -10.00% 0 2004 2005 2006 2007 Burning Off Excess Inventory No significant rebound in starts until inventory reduced to 5 months supply. Starts soften…but does not help inventory conditions 85% of inventory comes from Sub-Prime Defaults Force a Tightening in Lending Standards Reflects a new assessment of risk-return philosophy – beyond mortgages and perhaps globally. Tapping Home Equity Not as Viable As In the Past Can Debt Based Consumer Spending Thrive In This Environment? If not, growth in consumer spending slows. Income Growth is Improving – but perhaps not fast enough. Single Family Affordability Trend: New Homes Percent Change Home Prices, Year Ago (%): Yellow New Mortgage Payment as % of Household Income: Red 20.00% 29.00% 27.00% 15.00% 25.00% 10.00% 23.00% 5.00% 21.00% 0.00% 19.00% Pricing Softness Will Improve Affordability -5.00% 17.00% -10.00% 15.00% 2004 2005 2006 2007 Projected Residential Slow Down in Job Growth Prolongs Recovery in Sales and Inventory Correction. Mid-2009 Recovery Nonresidential Construction Nonresidential Construction Nonresidential Growth Currently Strong Slowdown In Nonresidential Based on improving underlying fundamentals Low Base Strong Expected ROI Pent-up Demand Easy Credit Conditions Expected ROI Softens With Overall Economic Slowdown Pent-up Demand Diminished Credit Conditions Tighten Nonresidential Spending Projections Real PIP Construction $ 25% History Forecast 20% 15% 10% 5% 0% -5% -10% -15% -20% Tighter Credit & Slower Economic Growth May Rob Momentum From Nonresidential -25% 2003 2004 2005 2006 2007 2008 Nonresidential Spending Projections Percent Change, Y-O-Y, Dodge Contract Awards (Bar), Real PIP Construction $ Line 30% 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% Nonresidential Dodge Contract Award 1999 2000 2001 2002 Data Has Already Signaled a Decline in Activity 2003 2004 2005 2006 2007 Public Construction Public Spending Projections Real PIP Construction $ History 15% 10% Forecast Outlook Dismisses “Bridge Crisis” 5% 0% -5% -10% -15% 2003 2004 2005 2006 2007 Total State Revenues & Expenditures Billion $, NIPA Striped Yellow: Expenditures 1950 Solid Green: Revenues 1750 1550 1350 1150 950 Slim Margins. Small Changes in Conditions 750 Impacting Revenues can Impact Funds 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Dedicated to Construction Total Billion $ State Surplus/Deficit, NIPA Point One: • Growth slow down = slow down job creation. • Recession = Job Loss 60 40 Point Two: •Job growth = state revenues growth Point Three: 20 0 •Entitlement pressures grow unabated. Point Four: -20 • Growth slow down = slower growth in state surpluses. -40 •Recession = potentially largest state deficits in history…longer lasting that 2001 recession. -60 1995 1997 1999 2001 2003 2005 2007 2009 2011 Public Sector = Largest cement consuming construction sector. Next Issue Emerging on Horizon Slowdown in job creation State revenue growth slowdown State Fiscal crisis could re-emerge Solvency of Highway Trust Fund Inadequacy of “real” SAFTEA-LU Market Conditions Conclusions Conclusion Sub-prime crisis has leaked beyond housing sector. Impact may hit nonresidential construction in 2008 and public construction in 2009 Recession risks increased significantly Downside risks to forecast Add extra dose of conservatism to plans Cement Outlook: 2008 Reed Construction Data Construction Forecast Conference Washington, D.C. October 4, 2007 Ed Sullivan Staff Vice President and PCA Chief Economist